Accounts Receivable Factoring
Accounts Receivable Factoring Overview
Accounts Receivable Factoring, which is known by several names, is commonly called accounts receivable factoring, invoice factoring, and sometimes accounts receivable financing, although accounts receivable financing is a term more accurately used to describe a form of asset based lending against accounts receivable.
Accounts Receivable Factoring is a financial transaction that is a common method of trade finance that provides immediate liquidity to companies that sell their accounts receivable at a discount. Although the discount in the face value of the accounts receivable is a cost, companies benefit in converting their accounts receivable to immediate cash, and their accounts receivable are typically sold without recourse.
Factoring is often an ideal solution for companies that need extra cash for inventory, payroll or marketing because it provides immediate cash based solely on invoices already on their books, so it requires no borrowing. Companies can access quick cash from their invoices to start their next project. Accounts Receivable Factoring can be utilized as needed or on a continuing basis.
In the world of global trade finance, Accounts Receivable Factoring can be a tremendous advantage to companies who use factoring as a trade funding method to put themselves in a position to offer credit terms to international customers in export finance transactions while still receiving cash when the goods they are exporting are shipped. The offering of credit terms to customers can be a tremendous competitive advantage.
Traditional Accounts Receivable Factoring is an ideal solution for companies that need extra cash flow to purchase inventory, cover payroll, invest in marketing, or virtually any use of immediate liquidity. Companies that factor their accounts receivable create an immediate influx of cash based entirely on invoices which are already on their books. In a typical Accounts Receivable Factoring transaction, the finance provider, who is known as the factor, purchases the accounts receivables and advances 70% to 90% of the total amount to the company in 24 to 48 hours. The factor then pays the remainder of what is owed to the company once the client pays the factor for the outstanding invoices, which is usually 30 to 45 days later.
Factoring is not the same as invoice discounting which is called an “Assignment of Accounts Receivable” in American accounting, as propagated by FASB within GAAP. Factoring is the sale of receivables, whereas invoice discounting (technically “assignment of accounts receivable” in American accounting) is borrowing that involves the use of the accounts receivable assets as collateral for the loan.
Small business owners opt for this form of factoring when they do not want to factor all of their invoices. Typically, businesses will want to spot factor when they don’t need a steady flow of cash or have varying gross margins where it does not make sense to factor. Unlike traditional factoring, where the company turns over all invoices, spot factoring is available on an as-needed or one-time basis. This flexibility comes at a premium but often makes sense if you have one client that is particularly slow or if a consistent flow of capital is not needed.
Construction finance offers sub-contractors and general contractors access to quick cash from your invoices so you can get the funds you need to start your next project. The financier (factor) purchases construction invoices and advances a percentage—often within 24 hours—then collects the funds and forwards the remainder of the invoice to you, less a factoring fee. Few factoring firms work with the construction industry, but we have direct lines into those that do. We will help you find the financial partner that will provide the best solution for your company’s particular situation.
Export factoring works for companies that want to offer terms to international customers but still want to receive cash when the goods are delivered. The factor or finance company, purchases your receivables and forwards payment, usually 70% to 90%, once it has the receivables documentation. The client pays the factor, not you, once it receives the goods. The factor pays you the balance when it receives payment from the customer, less a small fee.
Medical Services Factoring
Medical Services Factoring fills the cash gap inherent with receivables of third-party payers, such as insurance companies, Medicare or Medicaid. It gives you quick access to funds to pay bills, payroll, and buy equipment. With Medical Services Factoring, you perform a service and send the invoice to the factor. The factor then forwards a percentage of the invoice to you. After the factor collects the invoice from the debtor, you receive the remaining amount on the invoice, less the factoring fee.
Recourse v Non-Recourse Factoring
Recourse Factoring is appropriate if you have financially healthy clients. You agree to buy back or exchange with other invoices of equal or greater value, noncollectable invoices. Recourse factoring offers lower fee because of less risk.
Understanding Accounts Receivable Factoring
A factor is a financial intermediary that purchases receivables from a company. The factor is essentially a financier and funding source that agrees to pay the company the value of their invoices less a discount for commission and fees. The factor advances most of the invoiced amount to the company immediately, with the balance paid upon receipt of funds from the invoiced party. Factoring helps a business to obtain immediate capital based on the future income attributed to a particular amount due on an account receivable or business invoice. Accounts receivable function as a record of the credit extended to another party where payment is still due. Factoring allows other interested parties to purchase the funds due at a discounted price in exchange for providing cash up front.
The terms and conditions set forth by a factor may vary depending on their own internal practices. Most commonly, accounts receivable factoring is performed through third party financial institutions, referred to as factors. Factors often release funds associated with newly purchased accounts receivable within 24 hours. Repayment terms can vary in length depending on the amount involved. Additionally, the percentage of funds provided for the particular account receivables, referred to as the advance rate, can also vary. Accounts receivable factoring is not considered a loan because the parties don’t issue or acquire debt as part of the transaction. The funds provided to the company in exchange for the accounts receivable is also not subject to any restrictions regarding use.
Accounts Receivable Factoring Glossary
Accounts Receivable are monies which are owed to a company by its customers for products and services the company has provided. Once invoices have been sent to customers accounts receivable become current assets on the company’s balance sheet.
Accounts Receivable Factoring
Accounts Receivable Factoring is a method of Trade Financing whereby a company sells their accounts receivable in exchange for working capital. The purchaser of the receivables relies on the creditworthiness of the customers who owe the invoices, not the subject company.
Asset Based Lending
Asset Based Lending is a method of Trade Financing that allows a business to leverage company assets as collateral for a loan. Asset-based loans are an alternative to traditional debt which are generally characterized as higher risk and higher interest rates.
Commercial Finance is defined as the offering of loans to businesses by a bank or other lender. Commercial loans are either secured by business assets, accounts receivable, etc., or unsecured, in which case the lender relies on the borrower’s cash flow to repay the loan.
Factoring is the selling of a company’s accounts receivable at a discount. The lender assumes the credit risk of the debtor and receives the cash when the debtor settles the account.
Receivable Management involves processing activities related to managing a company’s accounts receivable including collections, credit policies and minimizing any risk that threatens a firm from collecting receivables.
See also: Trade Finance Glossary »
Frequently Asked Questions
Visit Forfaiting Services, which is very similar to accounts receivable factoring, but utilizes longer-term receivables.